General Securities Representative (Series 7) Practice Exam

What occurs to the premium during an odd stock split?

1. It remains unchanged

2. It decreases

3. It increases

4. It becomes zero

The correct answer is: It increases

In the context of an odd stock split, the premium associated with stock options typically decreases. Stock splits affect the number of shares outstanding and the price per share, but they do not directly alter the total market capitalization of the company. When an odd stock split occurs, shares are divided into a different ratio that is not a standard split like 2-for-1 or 3-for-1. For instance, in a 5-for-3 split, an investor holding 3 shares will now have 5 shares, but the price of each share will adjust accordingly in order to keep the total investment value the same. As a result, the options market will also adjust the strike prices and the number of shares the options are based on to reflect the new structure of the stock. Since the stock price adjusts downwards to accommodate the increased number of shares, the premium on options may reduce as well because the underlying stock's value has changed. The perception of value in options related to a higher stock price would typically be reflected in a higher premium. Thus, the adjustment during the stock split influences the premium negatively, leading it to decrease rather than increase. Understanding how stock splits interact with options trading is crucial for options pricing and strategy, as these adjustments